Don’t be complacent: IMF

The International Monetary Fund is warning central banks around the world to avoid complacency caused by benign inflation since the global financial crisis.

“Low consumer price inflation does not necessarily equate with a lack of economic imbalances," the fund said in a report released in Washington on Tuesday.

In a study that looks at whether inflation has been “muzzled or was it just sleeping", the IMF concludes that price pressures remain low because long-term expectations have become more firmly anchored.

At the same time a long period of price stability in the world’s major economies – even though unemployment has climbed sharply after the crisis – suggests inflation is less driven by cyclical changes in the economy, the fund notes.

Taken together, these two factors mean central bankers should not fear the use of extremely low interest rates and so-called unconventional monetary policy such as quantitative easing.

The findings come after months of speculation about an increasing global currency war, partly triggered by Japan’s decision to effectively devalue its currency.

Japan’s central bank last week announced plans to purchase large amounts of bonds to drive down long-term interest rates in a bid to generate 2 per cent inflation following almost two decades of deflation.

However, the IMF report lists a number of dangers posed by such policies and calls on central bank policymakers to remain alert to the risks.

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The first is a need to prevent imbalances, such as property bubbles, from emerging. The second is the prospect of political pressure and an erosion of central bank independence.

“History clearly demonstrates the risks associated with curtailing appropriate monetary tightening in response to persistently rising inflation," the report says. “The end result can be the disanchoring of inflation expectations and stagflation."

The fun highlights that there may be pressure on central banks to maintain their unconventional monetary policy settings as an economic recovery gathers momentum.

“These policies may be hard to reverse," the report says.

The inflation report will be included in this month’s IMF world economic outlook.